Please find the next blog in our monthly series that provides timely market data as well as perspectives on the current state of the economy and the global financial markets.
The global economy finds itself unusually calm, despite being surrounded by several strong currents. As it relates specifically to the US, there has been inconsistent economic data combined with unfolding political developments. The Commerce Department provided the advance release of 2Q-17 real gross domestic product (GDP), suggesting accelerated consumption and non-residential investment produced annualized growth of 2.6%. While this more than doubles the 1Q-17 reading, it was accompanied by negative GDP revisions for six of the past seven quarters. The latest report on personal consumption expenditures (PCE) indicated that spending was up modestly in June, with gains in services offsetting declines in finished goods (particularly autos). Core PCE, the Federal Reserve’s preferred measure, has now increased by 1.5% on a year-over-year (YoY) basis. With total personal income unchanged in June, the national savings rate dropped to just 3.8%, which is the lowest level since late 2008.
The unemployment rate dropped back to 4.3% in July, reflecting the continued health of the labor market. Nonfarm payrolls exceeded expectations, with 209,000 jobs added. The labor force participation rate inched higher to 62.9%, and the combination of lower unemployment with higher participation is a positive sign. Wage growth was simply in line with muted expectations, continuing its relatively slow pace of 2.5%. Given technology advances, some economists are questioning the ongoing validity of the Phillips Curve, which historically links rising wages with labor market tightness.
As expected, The Federal Open Market Committee (FOMC) did not change the federal funds rate at its late July meeting. Acknowledging offsetting forces impacting its mandate, the intent to gradually normalize monetary policy was confirmed. The time frame for the balance sheet reduction program was revised from “this year” to “relatively soon.”
There have generally been mostly positive signals from areas outside of the US. Foreign central banks remain quite patient with policy normalization given no clear sign of impending inflation. The strength of the Euro versus the US dollar may present some eventual growth headwinds as the region’s exports become more expensive. China’s construction sector showed strength with the sub-index for activity rising to 62.5 in July, the highest level since December, 2013. Politically, China is in the middle of the North Korea missile situation, and questions remain about the outcome of the 19th Party Congress this fall.
The combination of moderate economic growth, low inflation, and a tepid pace of monetary policy change has created a comfortable scenario for investors, allowing global risk assets to continue appreciating in July. Domestically, large cap stocks outperformed small caps. The S&P 500 was up another 2.1%, and achieved record closing levels on five separate occasions. Although divergence is developing within sectors and individual stocks, uncommonly low index-level volatility has been a hallmark of financial markets this year. Of note, the S&P 500 benchmark is riding its second longest stretch since 1950 without a 3% fall, and it has been over a year since it fell by 5% or more.
In general, public company reports for 2Q-17 have been very strong, both in top-line revenues and in earnings. Forward looking management guidance has been mixed, but strong enough to suggest that recent success should not be viewed as an aberration. Across the large cap sectors, Telecom (5.1%) and IT (4.3%) led the way in July. Telecom was helped by better than expected results from AT&T, Sprint and Verizon. No sectors posted a loss, but Industrials (flat) and Consumer Staples (0.4%) were the laggards. In the small cap space, Russell 2000 growth stocks (0.8%) outpaced value stocks (0.6%). Tax reform is still on the docket for later this year, and could potentially drive M&A, but expectations are muted given the lack of legislative accomplishments thus far in the Trump presidency.
Aided by ongoing declines in the US dollar, international equity returns for July were up solidly across the board. MSCI EAFE (2.9%) showed strong growth, but paled in comparison to MSCI Emerging Markets (6.0%), which was led by MSCI Emerging Markets Latin America (8.3%). Brazil continues to recover from its political scandal, with an impressive 10.9% return for the month. India and China were not far behind, up 9.0% and 8.9%, respectively. In the developed world, Japan (2.0%) showed strength, but trailed MSCI Europe (3.0%) and MSCI Pacific ex Japan (4.3%).
Real estate had moderate returns in July with the FTSE NAREIT US Real Estate index up 1.2% and the FTSE EPRA/NAREIT Developed up 1.9%. The Alerian MLP index trimmed year to date (YTD) losses, gaining 1.3% for the month. The Bloomberg Commodity Index was up 2.3% in July. Nymex West Texas Intermediate (WTI) oil had its best month since April 2016, gaining 9.0% on US dollar weakness and favorable supply data. Gold was up another 2.0%.
Fixed income assets maintained an upward trajectory throughout July. The broad Bloombar Global Aggregate index posted an impressive gain of +1.7%. The benchmark’s YTD total return of +6.2% is higher than most expected since yields remain depressed from a historical perspective. With the sustained decline in the US dollar (especially relative to the Euro), the resulting positive impact of currency translation for US-based investors remains the primary driver. This factor alone accounted for 80% of the unhedged benchmark’s monthly return.
The US Treasury (UST) yield curve reversed course and steepened modestly in July. Amid increased uncertainty around future FOMC rate hikes, policy sensitive 2-year UST yields stayed well-anchored and actually closed the month slightly lower at 1.35%. The general risk-on tone supported a rise in longer-term rates and the 30-year bond closed at 2.90%. The 10-year breakeven rate implied by TIPS moved higher, helping inflation-protected issues to outperform nominal UST.
With the implied probability of an additional Fed rate hike before year-end falling to approximately 40%, the market’s interpretation of gradual policy adjustments looks increasingly dovish. The FOMC’s September 19/20 meeting will be key to watch. This meeting will likely include revised economic projections, a new “dots plot,” and potentially the commencement of the balance sheet reduction program, commonly referred to as Quantitative Tightening (QT). It is expected that pre-meeting signaling will be aimed at reducing the chance of surprise. However, any unanticipated eagerness on the part of the Federal Reserve is a tail risk that could prompt an adjustment in asset prices.
The Bloombar US Aggregate index rebounded with a return of +0.4% in July. The Bloombar US Corporate Investment Grade index added just over +0.7% for the month, as insatiable investor demand overcame heavy supply. Credit spreads finished within 3 basis points (bps) of 10-year lows. The Bloombar US Corporate High Yield index provided enhanced returns of +1.1%, with energy-related names reacting to higher oil prices and spreads contracting overall. Emerging market bonds (particularly local currency issues) extended their impressive YTD rally, driven by the attractiveness of higher interest rates versus developed market bonds and steady/improving economic fundamentals.
Disclaimers: The data contained in this report is provided from Asset Consulting Group (ACG). This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. In preparing these materials, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public and internal sources. Gryphon Financial Partners shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This was created for informational purposes only. Gryphon Financial Partners, LLC is a Registered Investment Adviser.